Fibrosis can develop in most organs and causes organ failure. The most common type of lung fibrosis is known as idiopathic pulmonary fibrosis, in which fibrosis starts at the lung periphery and then progresses toward the lung center, eventually causing respiratory failure. Little is known about the mechanisms underlying the pathogenesis and periphery-to-center progression of the disease. Here we discovered that loss of Cdc42 function in alveolar stem cells (AT2 cells) causes periphery-to-center progressive lung fibrosis. We further show that Cdc42-null AT2 cells in both post-pneumonectomy and untreated aged mice cannot regenerate new alveoli, resulting in sustained exposure of AT2 cells to elevated mechanical tension. We demonstrate that elevated mechanical tension activates a TGF-beta signaling loop in AT2 cells, which drives the periphery-to-center progression of lung fibrosis. Our study establishes a direct mechanistic link between impaired alveolar regeneration, mechanical tension, and progressive lung fibrosis.